Resurrected M3 may warn of inflationary blowoff in U.S.

By Ambrose Evans-Pritchard
The Telegraph, London
Monday, July 16, 2007

http://blogs.telegraph.co.uk/business/ambrosevanspritchard/july07/m3mone...

If you thought the US Federal Reserve made a grave mistake abolishing data on the M3 money supply last year, you at last have a heavyweight ally in the City of London.

A number of private citizens have heroically kept the M3 flame alive. Hats off to them.

Now Capital Economics has joined the fight. The research group so disturbed by the (clandestine0 surge in broad money that it has decided to publish an update of its own on the 20th of every month, based on the old Fed model.

As you can see from the chart above [found at the link above], M3 is now rising at over 10 percent a year and has been on a sharply upward trajectory for the last 18 months. This has been accompanied by a 15 percent rise in global liquidity, as shown below [found at the link above], based on worldwide dollar holdings.

"The Fed's decision to discontinue publishing the M3 figures increasingly looks like a mistake," says the group's chief US economist, Paul Ashworth.

"Monetary aggregates are enjoying a resurgence in popularity at the Bank of England and never went out of fashion at the European Central Bank," he said. Surging M3 has prompted both to step up the pace of rate rises.

I would add the Swiss, Scandinavians, and of the course the Bank of Japan. In truth, the Fed is now completely out of line with the central banks across the world and is perilously close to losing credibility. The others are all fretting that unbridled expansion of the money supply is leading to liquidity driven asset bubble.

Japan lived through this in the 1980s when it allowed property and stocks to mushroom out of control, mistakenly thinking that the effects would be benign because retail price inflation was low. (The US did much the same in the 1920s but the collective mind in Washington and New York seems to forgotten that).

Capital Economics makes a different argument. Mr Ashworth said his group at first supported the Fed's decision, agreeing that (narrower) M2 was good enough on its own.

"Recent evidence has made us reconsider that position. It appears that broad money and consumer prices have begun to move in tandem once again. Over the past two years M3 growth may even have been leading core inflation by a few months," he said.

Implication: Inflation is about to jump up again.

Now there are broadly two schools of thought on this:

A) We get old-fashioned inflation.

And B) we get the Japan treatment. (That is, a deflationary bust when the bubble bursts.)

Albert Edwards, global strategist at Dresdner Kleinwort, a fan of the Austrian School, is opting for the deflationary bust.

"The Fed has been blowing after bubble and it has become a Ponzi scheme: It has to keep going just to stop toppling over. We're now at the end of the game. The risk is that the US will topple into deep recession, and if that happens equity prices have a long way to fall, perhaps 45 percent," he said.

Coward that I am, I can't decide which way this is going to break. But I do feel sure that the Fed has created massive imbalances by holding interest rates below their natural level. This Greenspan strategy steals prosperity from the future. Eventually the future arrives. Like now?

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